Beware of Investing in the Next Sure Thing

I have a friend who’s very interested in making a lot of money very quickly. No, he’s not Homer Simpson.

He’s a good guy, so I entertain his questions. Over the years he’s thought about investing in a series of hot internet stocks (way back in the 1990s), gold/silver, apps, and water, right after watching The Big Short.

His newest idea is marijuana. He enjoys a toke every now and then, as do most of his friends. He can see the potential fully legal weed has. It’s pretty much a sure thing. Naturally, he’s ready to put at least 42.0% (niiiiiiiiiice) of his portfolio into wacky tabaccy and then get a snack afterwards.

So he comes to me with a request. “Nelson” he says “tell me which marijuana stock I should invest in. Also, take a shower. You disgust me.”

That sounds like two requests, actually. And sternly worded ones at that. More of a command, really.

I took a quick look at the alternatives out there, and let me tell you guys. There isn’t much.

Marijuana investments

The big marijuana player in Canada is Canopy Growth Corp (TSX:CGC), which has just recently graduated from the TSX Venture onto the main exchange. It’s the first such stock to do so in North America.

It’s a legitimate business, generating $18 million in sales over the last year. Profits aren’t really happening as of yet, with the company posting an $8 million loss in the last twelve months. Profitability won’t happen for at least another couple of years. Management would much rather invest in new grow-ops.

Here’s a chart of Canopy over the last three months, since it leapt from the TSX Venture to the TSX.

Overall, it’s up 85% in just over three months. That’s good. The last week or so? That’s not so good. Shares are down 15% in just a few days. The only real news I can see is a couple of analysts warned shares were getting overvalued. That alone was enough to bring the company down 15%.

Canopy might be one of the most expensive stocks in the world. It trades at 36 times revenue. That compares to the following also expensive stocks:

Stock

Price-to-sales

Netflix

6.6

Facebook

17.3

Amazon

3.3

Chipotle

3.1

Twitter

5.0

Canopy

36

One of those is not like the others. Also, Chipotle may not have been the best choice.

We all know why Canopy is expensive, right? Every Tom, Dick, and Harry has decided legal pot is going to be a bigger deal than Fred Durst in 1998. Thus, the valuation is completely out of whack.

This will always happen

Here’s the problem with investing in the next sure thing. You’re always going to pay a huge premium for it.

The market is filled with smart people. Some of these folks can recognize investing trends years in advance. There was some guy out there investing in the tech revolution in 1993, social media in 2004, and the upcoming legalization of pot in 2013. Usually such investments are made privately, because these industries are so tiny they’d never make it on the stock exchange.

After a number of years and an increasing amount of hype, the next big thing ends up publicly traded. A number of smart investors start paying attention to it, start getting excited, and start buying with all the gusto of yours truly at an all-you-can-eat dessert bar.

Once the stock has gone up enough, guys like you and I and my friend start hearing about it. We invest at precisely the wrong time, and you all know what happens next. I start a blog called The Stock Market is Rigged, and y’all show up just to laugh at me.

By the time the average person has heard of the next sure thing the smart money has already profited from it. Hell, you’re probably buying their shares.

So how do you tell?

How is the average investor supposed to know if a trend is played out?

Specifically, spend some time on Wall Street Bets, which is where dumb money goes to die. Wall Street Bets is the perfect sentiment gauge of retail investors. If they’re talking about something, chances are it’s peaked. It’s time to hit the sell button so hard you’ll click right through your mouse.

Even if your next investing craze hasn’t yet been mentioned on Wall Street Bets, you should still be wary. It’s one thing to be bullish on the future of an industry. That’s an important part of any investment. It’s quite another to base your entire investing decision on the fact the sector is going to explode.

In 1910 there were hundreds of car manufacturers in the United States. How was the average investor supposed to tell which one was going to succeed? There were thousands of tech companies in the 1990s. How could the average investor know which one was going to be Amazon and which one was toys.com without the benefit of hindsight? You can’t. At least, I can’t.

The ultimate lesson? Don’t even try. Stick your cash in a well-diversified portfolio of index funds and keep the speculation to your weekly lottery ticket. There’s no such thing as a sure thing in investing.